Short term pain is long term gain for Indonesia's economy

Short term pain is long term gain for Indonesia's economy

Ahmad Pathoni, Agence France-Presse/Jakarta

A massive rise in fuel prices has resulted in short term pain for Indonesia amid soaring inflation and jacked-up interest rates which threaten higher unemployment and social unrest.

Analysts remain convinced however that the government's policy of abandoning fuel subsidies will pay off over the longer term and deliver fiscal stability for Southeast Asia's largest economy.

David Chang, research director at Kresna Securities said financial markets and industries would be badly hit for the next six months by the rising costs of living before the economy improves.

"I would think that the decision to raise fuel prices is the correct decision," he told AFP. "Unfortunately, Indonesia has to go through a period of hardship."

However, Chang added the overall outlook remained solid.

The government slashed fuel subsidies on Oct. 1 after its currency was battered to a four-year low as it was sold off to snap up dollars to pay for oil imports priced at historic highs.

Fuel prices rose an average of 126 percent as a result, forcing hundreds of protesters onto the streets around the nation and about 70,000 workers in the country's textile sector alone to lose their jobs.

Benny Sutrisno, chairman of the Indonesian Textile Association, was quoted by Antara news agency as predicting 100,000 workers will have been dismissed by the end of the year.

Protest rallies that followed the price hike were small by Indonesian standards and came nowhere near the fevered frenzy of 1998, when ex-dictator Suharto was toppled after raising fuel prices amid Asia's then economic crisis.

But data released last Tuesday showed that the full brunt of an economic storm may have only just arrived, with inflation for October clocking in at 8.7 percent from September, or 17.9 percent higher year-on-year.

This was way above expectations.

Bank Indonesia (BI) had forecast a month-on-month rise of 5.0 percent and the enormous spike prompted the central bank to immediately hike its key interest rate by 125 basis points to 12.25 percent.

The rate was just 8.75 percent in August.

BI is also forecasting economic growth for 2005 at between 5.5 and 6.0 percent, which compares with the government's annual growth forecast of 6.0 percent.

Song Sen Wun, a regional economist at Singapore-based CIMB-GK Research, said the sharply higher than expected inflation number was partly due to fuel price hikes being implemented ahead the festive season marking the end of the Muslim fasting month of Ramadhan.

Traditionally, this is a period when people spend-up big, buying gifts for relatives and friends before traveling back to their home provinces, thus adding further pressure to the inflation figures.

"This kind of inflation is inevitable because of the big jump in fuel costs. Certainly businesses are trying to exploit the high fuel costs. There will be people who overcharge," he told AFP in regards to the holy month.

He said the government had made the right decision in raising prices and that inflation figures were still at a level the economy could tolerate, with prices expected to ease in November and December.

"Inflation will come off from early 2006 and the second half of 2006, more significantly. This is short term pain for the economy," he said.

The hike also created "a valid foundation for the economy to rebuild" but Song cautioned the government must now deliver on economic reform, specifically in tackling corruption and attracting foreign investment.

Standard Chartered economist Fauzi Ichsan agreed but warned that rising interest rates risked increasing unemployment and poverty.

And this could outweigh the intended fiscal benefit, with the overall impact putting a drag on economic growth, he added.

However, he was also adamant that the policy of abandoning fuel subsidies should help the economy over the longer run.

"The fuel price increase was so steep that its impact on prices is immediate but I expect it will be one-off and after that inflation will fall gradually," he said.